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Don't delay
Planning now may help you achieve a prosperous retirement

Let's face it, who doesn't want a retirement that's not just secure but prosperous? The key is to work at building your retirement nest egg now. The Pension Protection Act of 2006 (PPA) may help you reach your goals even faster: It makes permanent many provisions from the 2001 tax act that were set to expire after 2010, such as the higher annual contribution limits for IRAs, 401(k)s, 403(b)s, 457s and SIMPLEs, and the catch-up provisions for those 50 and over. Here are some strategies to consider.

Anticipate inflation's effect.
If your retirement is many years in the future, considering how inflation will affect your retirement living expenses is especially important. For best results, take into account two periods of inflation: the time you'll be accumulating retirement funds and the estimated length of your retirement. Knowing exactly how much the cost of living will increase is impossible, but past inflation rates can help you generate a likely estimate. Equally important, life expectancies are increasing, and a longer retirement period means you'll need more assets built up so your money can survive as long as you do.

Contribute to a traditional IRA.
You may be able to take an above-the-line deduction for traditional IRA contributions up to $4,000 or 100% of earned income, whichever is less. Taxpayers age 50 and older can also make "catch-up" contributions of up to $1,000. The contribution limits will increase in future years. But if you or your spouse participates in an employer-sponsored plan, your deduction may be limited based on your adjusted gross income (AGI).

CHART 5:
2007 RETIREMENT PLAN CONTRIBUTION LIMITS

Plan type Contribution
limit Contribution limit
for taxpayers
50 and over

Traditional and Roth IRAs $4,000   $5,000

401(k)s, 403(b)s, 457s and SARSEPs¹ $15,500   $20,500

SIMPLEs $10,500   $13,000

SEPs and defined contribution Keoghs $45,000   $45,000²

¹ Includes Roth versions where applicable.

² Not subject to "catch-up" provisions.

Data source: U.S. Internal Revenue Code

Consider a Roth IRA.
Like a traditional IRA, a Roth IRA may allow you to make annual contributions of the lesser of your compensation for the year or $4,000 (reduced by annual contributions to all your other IRAs), plus a catch-up contribution of $1,000 if you're age 50 or over. The contribution limits also will increase in future years. You can't deduct contributions, but you can take qualified distributions tax free. Your contribution may also be limited based on your AGI. If eligible, consider converting your traditional IRA (or another retirement plan, once it's been rolled over to an IRA) to a Roth IRA. This option will be available to more taxpayers starting in 2010, when the AGI limit (currently $100,000) for eligibility will be waived.

Maximize contributions to employer-sponsored plans.
Because contributions are pretax, they reduce your taxable income. The 2007 limit for employee contributions to 401(k), 403(b), 457 and SARSEP plans is the lesser of 100% of compensation or $15,500 ($500 more than in 2006). Plus, your employer may match some or all of your contributions — also on a pretax basis. And plan assets grow tax-deferred. Similarly, under a SIMPLE, you may elect to contribute up to $10,500 of your salary pretax, and your employer is required to make contributions as well. Again, assets grow tax-deferred. Contribution limits are scheduled to rise, and taxpayers age 50 and older can make additional "catch-up" contributions to these plans. (See Chart 5.)

Take advantage of the Roth 401(k).
PPA makes permanent the Roth contribution provision, which means more employers are likely to amend their plans to allow them. If you participate in a 401(k) or 403(b) plan and the plan allows it, you may designate some or all of your elective contributions as a Roth contribution. Unlike regular 401(k) contributions, Roth 401(k) contributions are taxed, but plan assets grow tax free. And, in contrast to a Roth IRA, there's no phaseout of eligibility based on AGI.

Save more with a Keogh, single-employee SEP or solo 401(k).
If you're a business owner or self-employed, you may be able to deduct contributions to a Keogh, single-employee SEP or solo 401(k). This year, the annual contribution limit for defined contribution Keogh plans goes up $1,000 to $45,000, as does the limit on single-employee SEP contributions. Also, if you're age 50 or over you can augment your solo 401(k) savings with the catch-up contribution, which for 2007 is $5,000. Limits for all three plans are indexed for inflation each year, and their earnings accumulate tax-deferred.

Tax Action Strategy:
BE AWARE OF YOUR RETIREMENT PORTFOLIO

Consider which investments you should hold inside and outside your retirement accounts. For instance, if you hold taxable bonds to generate income and diversify your overall portfolio, consider holding them in an IRA or qualified retirement plan where there won't be a current tax cost. But try to own dividend-paying stocks that qualify for the 15% tax rate outside of retirement plans so you'll benefit from the lower rate. Keep in mind that, unless Congress extends it, the 15% dividend rate is available only through 2010. Also, periodically reallocate your retirement plan assets. For example, the allocation you set up for your 401(k) plan 10 years ago may be too aggressive now that you're closer to retirement.

Avoid early withdrawal penalties with a lump-sum rollover.
With a few exceptions, retirement plan distributions made before age 591/2 are subject to a 10% penalty. But when you change jobs, you may receive a lump-sum distribution from your employer's retirement plan. To avoid being penalized, consider rolling it over to the plan sponsored by your new employer within 60 days. Or, roll it over into a traditional IRA, which may give you more investment choices. Either way, a rollover will avoid current income tax and early withdrawal penalties while allowing the assets to continue to grow tax-deferred. If possible, transfer by direct rollover to avoid any income tax withholding issues.

Plan for required minimum distributions.
For employer-sponsored plans and traditional IRAs, once you reach age 701/2 you're subject to the required minimum distribution rules. There's a narrow exception to this rule for an employee: If your plan allows, you don't own more than 5% of the company and you continue to work after age 701/2, you won't be subject to the rules on an employer-sponsored plan until you retire.

Whether you should take distributions before age 701/2 or more than the minimum after that age depends on how much you'll receive from other income sources, your life expectancy and other factors. Generally, maximizing tax-deferred growth provides more savings if you can afford to leave the funds in the plan — even if it means depleting other investment accounts.

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